Evergrande: what’s behind the bursting of China’s property bubble?

China’s President Xi is facing a momentous decision as he considers whether to bail out the debt-ridden Evergrande, one of China’s biggest property developers, writes Mattie Brignal.

The beleaguered multinational is on the brink of collapse as it struggles to pay the interest on a $305bn mountain of debt. Shares in Evergrande Group tanked 10 per cent in Hong Kong trading on Monday, setting off a ripple of fear across Asia, Europe and the US that the developer could default. 

The S&P 500 fell 1.7 per cent, as did Europe’s region-wide Stoxx 600 index. Evergrande’s own share price has plummeted by 80 per cent this year.

Experts are warning that a collapse could send shockwaves across China’s financial system and beyond. Uday Kodak, founder of India’s Kotak Mahindra Bank and the world’s richest banker, has described the Evergrande crisis as “China’s Lehman moment”, referring to the collapse of Lehman Brothers which precipitated the 2008 financial crash.

Evergrande has long been the poster-boy of Chinese real estate. For decades, the property giant surfed a property boom, expanding into 280 cities and peddling the dream of home ownership to China’s ballooning middle class. It borrowed aggressively to become one of the country’s biggest companies, expanding into a range of new sectors from media and finance to food and sport.  

But last year the Chinese Communist Party brought in new rules to rein in the borrowing of property developers, partly to shrink a growing property bubble and also as part of a wider push to curb what Xi sees as the excessive wealth of the country’s elite.  

The bubble now appears to be bursting. Supply for housing in China is outstripping demand, and hundreds of thousands of residences built and owned by Evergrande sit unfinished or empty.

The firm’s next interest payment of $84m on a five-year bond is due on Thursday. S&P Global Ratings have said that a default is “likely”.  Yields on the bond have skyrocketed to 560 per cent from just over 10 per cent earlier this year.

Analysts are warning of the “domino effect” a default could have on China’s property and financial sectors. Evergrande has 200,000 employees and indirectly creates more than 3.8 million jobs every year. Angry sales agents, unpaid contractors and investors have been protesting outside Evergrande’s Shenzhen headquarters since last week.

“Evergrande’s collapse would be the biggest test that China’s financial system has faced in years,” said Mark Williams, chief Asia economist at Capital Economics.

Any downturn in the world’s second-largest economy would inevitably have spillover effects beyond its shores. Phoenix Kalen, head of emerging-market strategy at Société Générale in London, said: “The repercussions from Evergrande’s prospective collapse will likely contribute to China’s ongoing economic deceleration, which in turn anchors global growth and inflation, and casts a pall over commodity prices.”

The Chinese government faces a dilemma which hinges on whether it believes Evergrande is too big to fail. Bailing out the firm will be seen as letting a reckless borrower off the hook, and incentivise over-leveraging in future. A disorderly collapse would be catastrophic for the firm’s employees and lenders – not to mention its customers who have already paid for 1.6m unfinished apartments – and scare away foreign investment.

Yet the CCP coming to the rescue before an anticipated collapse looks unlikely. According to S&P Global Ratings: “Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy.”

How Xi handles the crisis will be a key test of whether “capitalism with Chinese characteristics” really can provide the wealth and stability the CCP hopes for. It doesn’t look like it.